Educational Articles

There are certain places that investors can look in order to find issues that consistently offer above-market yields. Some investors just look at specific industries, like utilities or financials, to find high-yielding stocks. Others, however, look to certain types of securities with unique legal structures, like real estate investment trusts (REITs), or in this case, master limited partnerships (MLPs), to fill their income needs.

Stated simply, a master limited partnership is a publicly traded limited partnership. MLPs have two separate partners, a general partner and a limited partner. The general partner runs the company’s operations and holds all the voting power, while the limited partner provides the capital and reaps the benefits of the distribution payments. Indeed, a MLP’s “shares”, which are called units, are publicly traded and make up the vast majority of the partnership. They also comprise the limited partners’ stake in the entity. The general partner, on the other hand, is paid for its efforts via a management fee, which is typically 2% of distributable cash flow, plus incentive distribution rights (IDRs) once limited partner cash distributions exceed a certain level per quarter.

The high yields normally offered by MLPs stem from their legal structure. For tax purposes, MLPs are known as pass through entities. This structure is geared toward the distribution of profits and, legally, MLPs must pass along the vast majority of their earnings to the limited partners. The tax law considers limited partners to be owners of the partnership’s assets. Consequently, they are taxed on their proportionate shares of the partnership’s taxable income, calculated according to IRS rules, not generally accepted accounting principles. This structure helps MLPs avoid direct federal and state corporate income taxes, allowing these companies to pass larger distributions to their “partners” (i.e. unit holders). Because of the complex nature of these securities and their unique tax implications, investors may want to consult their tax advisors before investing in MLPs.

Of course, some MLPs are geared more toward income than others. To create our list, we used the online screening tools of The Value Line Investment Survey to highlight those MLPs with the highest dividend yields. While this list is a good jumping-off point for income-oriented accounts, investors should keep in mind that above-average yields can sometimes be a sign that a company is in trouble or that the dividend payment is at risk. On the other hand, a high yield may just as easily signal a good buying opportunity if a company is merely misunderstood. Our screen returned several interesting names, including Enterprise Products (EPD) and Kinder Morgan Energy (KMP)

Enterprise Product Partners

Enterprise Products Partners, L.P., is a leading integrated provider of natural gas and natural gas liquids processing, fractionation, transportation, and storage services in the U.S. and Canada. It operates in five segments: NGL pipelines and services, onshore natural gas, crude oil, offshore pipeline and services, and petrochemicals and refined products.

Enterprise Products is already large, with plans on getting even bigger. The partnership is in the midst of a significant construction program and plans on spending roughly $7.4 billion on a host of new projects set for completion by mid-2015. This is on the heels of more thank $4 billion in expenditures last year. The ECHO crude oil storage facility is likely to be fully operational shortly, which will provide shippers with 4.5 million barrels of storage capacity and access to the biggest concentration of refineries in the world. Another significant endeavor is the ATEX pipeline, which is scheduled to be completed by the end of the first quarter of next year. ATEX will deliver ethane production from the Marcellus/Utica shale areas to the U.S. Gulf Coast.

The partnership’s strong distribution growth record is poised to continue. Enterprise has raised its payout for 34 consecutive quarters, the most recent increase being $0.66 per unit in the March quarter, which reflected 6.5% growth from last year’s comparable period. Hence, we look for healthy payout increase for all of 2013, aided by strong results at its natural gas liquids businesses. What’s more, starting in the latter part of 2015, the annual growth rate should accelerate even further, as demands on the partnership’s cash flow ease following moderation of its capital-expenditure program.

These units are worthy of consideration by income-oriented accounts. The partnership’s vast presence and diversification into almost every aspect of the energy pipeline storage and transportation business positions it well for an upturn in the energy sector.

Kinder Morgan Energy Partners

Kinder Morgan Energy Partners, L.P. is the nation’s largest pipeline master limited partnership. It owns or has interests in about 46,000 miles of pipelines and 210 terminals. Its average daily volume in 2012 was as follows: over 2.0 million barrels of petroleum products and up to 8.4 billion cubic feet of natural gas. The CO2 segment moves about 1.3 billion cubic feet per day and its terminals handle over 557 million barrels per year.

Kinder Morgan Energy Partners had a very solid 2012. In the December quarter, profits increased in all five units, led by a 64% jump in natural gas pipeline results. This unit benefited from the “drop down” of interests in several pipelines from KMP’s parent, Kinder Morgan, Inc., which acquired these assets and others through its purchase of El Paso Corp., in late 2011. What’s more, CO2 profits rose sharply, on higher oil and natural gas liquids production, despite reduced NGL prices. Also, profits climbed 38% in the small Canadian division, reflecting lower taxes and some contribution from higher throughput.

Following decent bottom-line gains in 2013, we look for growth to be steady in 2014 and beyond. KMP has about $12 billion of projects for which it either has signed contracts or expects to sign them soon. The major project, a more-than-doubling of the Trans Mountain pipeline in Canada, accounts for about $5 billion and would not come on line until 2017. However, the $12 billion excludes acquisitions and probable expansion of present assets. Two particularly promising projects are increasing gas transport capacity to northern Mexico and reversing a pipeline that runs from west Texas to southern California. Increased demand in both places makes these ideas likely to be implemented, though no contracts are in place at this time.

These units pay a high current yield and have decent total return potential at the recent price. With the dropdown of former El Paso assets and a further $5 billion acquisition scheduled to close in this year’s third quarter, the partnership is competitively positioned to benefit from growing natural gas output. And, with interest rates likely to remain low, access to capital should be relatively easy.